India hikes interest rates to contain inflation

An Indian farmer carries wild grass on the outskirts of Jammu, India, Sunday, Oct. 31, 2010. The grass is used for making thatch for the roofs of huts. (AP Photo/Channi Anand)

/ AP

An Indian farmer carries wild grass on the outskirts of Jammu, India, Sunday, Oct. 31, 2010. The grass is used for making thatch for the roofs of huts. (AP Photo/Channi Anand)

An Indian farmer carries wild grass on the outskirts of Jammu, India, Sunday, Oct. 31, 2010. The grass is used for making thatch for the roofs of huts. (AP Photo/Channi Anand) (/ AP)

ERIKA KINETZ, AP Business Writer

India's central bank raised key interest rates for the sixth time this year on Tuesday to contain persistently high inflation - another sign of the gulf between fast growing emerging Asian economies and tepid growth in the developed world.

The Reserve Bank of India's quarter point hike in key rates was expected and bank officials said that barring unforeseen shocks, there would be no further hikes for at least three months.

"Unless there is some unforeseen development, we will refrain from action," Governor D. Subbarao said.

The Reserve Bank hiked the repo rate - the central bank's short term bank lending rate - to 6.25 percent. It raised the reverse repo rate - which the central bank pays on deposits - to 5.25 percent. It left the cash reserve ratio unchanged at 6.0 percent.

At 11.6 percent, India's consumer price inflation is higher than any other major economy. Since the end of the financial crisis, India, Australia and Brazil have emerged as the most aggressive monetary policy tighteners among major economies, according to Reserve Bank data.

Australia's central bank also jacked up its key interest rate in a surprise move Tuesday similarly aimed at warding off inflation. China began hiking rates in October.

Moody's economist Matt Robinson said the moves underscore "the widening gap between Asia's buoyant economic situation and that faced by its North American and European counterparts."

Indian policy makers are caught between strong growth at home and a fragile global economy, and the Reserve Bank said it would take steps to mitigate "lumpy and volatile" capital flows as necessary.

Ultra-loose monetary policy in the developed world has sent a flood of foreign money into emerging Asia as investors seek havens of high-growth. That has pushed stock markets, dealmaking and currencies to dizzying highs, hurting exports and creating fears of frothy equities, real estate and gold markets.

In raising rates, India has broken ranks with Thailand, South Korea, Indonesia and the Philippines, which have put rates on hold, worried that further hikes would attract even more foreign capital.

Unlike most emerging Asian economies, India is a net importer and needs to finance its widening current account deficit, making it more tolerant of large foreign capital flows than its neighbors.

Subbarao said capital flows are at roughly the same level as India's current account deficit - unlike in 2007 when foreign fund flows surged to about 9 percent of GDP, while the capital account deficit was just 1.8 percent of GDP, prompting intervention.

Subbarao declined to comment on whether the bank has joined other emerging Asian nations and intervened to push down the value of the rupee. Subbarao did not rule out instating more capital controls, similar to the taxes Thailand and Brazil have levied on foreign investors.

He did raise concerns about using volatile investment flows to fund the deficit.

"Should there be excess flows, we've used measures in the past. We'll use measures in the future," he said. "But I don't see abrupt action being taken."

The U.S. Federal Reserve is expected to this week join Japan in buying more government bonds and other assets to tamp down interest rates and competitively weaken the dollar.

That could drive even more capital offshore and put upward pressure on global commodities, further exacerbating inflation in India, which imports about three-quarters of its oil.

If the Fed goes ahead with a $500 billion buying program, liquidity could become a bigger driver of inflation than factors such as food supply bottlenecks, prompting more aggressive action from the bank, said Enam Securities economist Sachchidanand Shukla.

"They will have to intervene more aggressively in currency markets because of the risks from liquidity flows into the country," he said.

The bank said rising global commodity prices, coupled with domestic demand pressures, have made inflation its overriding concern.

Food inflation for September was 15.7 percent, down from 21.4 percent in May. High food prices are partly due to people eating more protein as they get richer, the bank said, making it unlikely that good rains alone will wash away food inflation.

Rising real estate prices and the use of temporarily low "teaser" loan rates have made the bank wary of a U.S. style housing bust. It said it wants commercial banks to increase provisioning for such loans to 2 percent, given the higher risks.

"We must rein in some loose practices in loans to the housing sector," Subbarao said.